Sixteen years of economic success creates its own challenges

June 8, 2007 — 10.00am

PETER Costello is entitled to enjoy the latest economic figures. These were remarkably strong, a "beautiful set of numbers" to match and indeed, job-wise, exceed the economic boasts of the Federal Treasurer's predecessor, Paul Keating. Economists were startled by the growth figures — output rose 1.6 per cent in the quarter for a seasonally adjusted annual rate of 3.8 per cent — and even more so by the jobs — the 39,400 created were four times predictions — as unemployment fell to 4.2 per cent. This is the lowest since November 1974 (although comparisons are complicated by changes since then that assess anyone working at least an hour in the week as employed).

Even better, workforce participation rates hit a record 65 per cent and evidence grew, as Mr Costello said, that "we are in a very strong business investment cycle" that will drive further growth. The mining industry has responded to a global boom with a record $43 billion in capital projects. While much is made of the resources boom, the flow-ons — good and bad — are being felt throughout the economy by businesses and households, and in retailing, services and construction. The growth is not just in mining. As ANZ chief economist Saul Eslake has identified, the Government has used revenue from soaring corporate profits for tax cuts that, with new jobs, lifted personal disposable incomes (up by a real annualised rate of 4.6 per cent in the past two quarters). That has helped boost demand across the economy.

All this has been achieved through the worst drought in a century, which cut farm production by 22.7 per cent over the year. Mr Costello cited the drought as a factor in the one obvious area of concern: the ever-increasing gap between export earnings and import and debt spending — debt is at record levels, both for households and the country. The terms of trade, with high prices for exports and low prices for (mostly Chinese) imports, have never been more favourable for a turnaround. Even so, Australia this week recorded its 61st consecutive current account deficit, a near-record $15.38 billion, to rack up a foreign debt of about $520 billion. The costs of servicing that huge debt are creeping up with global interest rates.

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Days before he won office in 1996, Prime Minister John Howard nominated two top priorities. The first was cutting youth unemployment. Here, the Government has delivered — as he said yesterday, "the greatest human dividend out of good economic management is jobs". His second priority in 1996 was reducing the "very high level of foreign debt and the disastrous state of our current account deficit". Instead, in recent years, import volumes have soared, while exports have languished — a trend disguised by high commodity prices. Of course, as Mr Howard has argued for many years now, the important thing is "your capacity to service that debt out of your revenue, out of your financial flows", as well as retaining the confidence of both creditors and the consumers whose spending underpins so much economic activity. Last weekend Mr Howard perhaps surprisingly nominated the elimination of government debt as the Coalition's greatest economic achievement, possibly because a big surplus now gives the Government a freedom of response to changing circumstances, which in turn helps maintain confidence in the economy.

There is, in fact, much more equanimity about Australia's foreign debt than a decade ago, because there seems little prospect of demand for exports — driven by China and India — dropping off any time soon. There is no sign of the economic shock that put 17 of 18 comparable OECD economies in recession in the early 1990s. Growth isn't just in Asia. Even in the 13 nations whose currency is the Euro, growth is the highest in a decade, unemployment is the lowest on record and the benchmark interest rate was lifted this week to 4 per cent, double that of 18 months ago. Australia's comparatively high official cash rate of 6.25 per cent is partly a reflection of risk, but the huge inflow of capital attests to continuing confidence in the economy. And with mining capital investment doubling in recent years, an export pay-off is widely anticipated.

That is why Mr Costello rightly highlighted business investment as a positive. Yet he also chose to describe the economy as "extremely delicately poised". There were "very big risks", starting with wage pressures and inflation in an economy operating close to capacity. He did so, of course, to draw voters' attention to the risk of taking on an "L-plate driver", Opposition Leader Kevin Rudd. However, it should not be forgotten Mr Costello was once on L plates, too. The focus ought to be not so much on personal characterisations as on the quality of policies for dealing with the challenges created by economic success: labour and skills shortages, coupled with mediocre productivity growth, plus high debt burdens as a product of confidence, which paradoxically makes Australians highly vulnerable to inflation and interest rate pressures.

The Coalition's focus has been on containing wage inflation, very successfully, which it attributes to WorkChoices. Labor's challenge is to persuade voters that scrapping those laws wouldn't lead to a wage break-out, particularly as the demography of an ageing population exacerbates labour shortages. (That surely is part of the reason why employers moved to secure staff on 66,800 new full-time jobs in May, as part-time jobs fell by 27,400.)

The skilled migrant intake, which has tripled under the Howard Government, is an overlooked factor in all this — last month the Reserve Bank noted migrants made up a third of growth in total employment since 2000, which has helped keep wage growth in check. The increase in skilled migrant places in the last budget was still only a quarter of what business wanted. Managing the politics and practicalities (of adequate infrastructure and environmental sustainability) of immigration remains a challenge for all parties.

As for lifting productivity — the other part of the equation, along with labour deregulation, for keeping down costs and inflation — Labor has begun making the case for investing more in education and skills training, and the Government responded in the last budget. The economy is doing well, some parts and people better than others, but that has created particular strains and risks. These demand sophisticated policy responses that go beyond either complacent Government backslapping or alarmist Opposition doomsaying.